Cash or stock dividends distributed to shareholders are not recorded as an expense on a company's income statement. Stock and cash dividends do not affect a company's net income or profit. Instead, dividends impact the shareholders' equity section of the balance sheet. Dividends, whether cash or stock, represent a reward to investors for their investment in the company.
While cash dividends reduce the overall shareholders' equity balance, stock dividends represent a reallocation of part of a company's retained earnings to the common stock and additional paid-in capital accounts.
Key Takeaways
- Cash or stock dividends distributed to shareholders are not recorded as an expense on a company's income statement.
- Cash dividends are cash outflows to a company's shareholders and are recorded as a reduction in the cash and retained earnings accounts.
- Stock dividends reallocate part of a company's retained earnings to its common stock and additional paid-in capital accounts.
Understanding Why Dividends are not Expenses
A cash dividend is a sum of money paid by a company to a shareholder out of its profits or reserves called retained earnings. Each quarter, companies retain or accumulate their profits in retained earnings, which is essentially a savings account. Retained earnings is located on the balance sheet in the shareholders' equity section. The cash within retained earnings can be used for investing in the company, repurchase shares of stock, or pay dividends.
The cost of dividends is not included in the company's income statement because they're not an operating expense, which are the costs to run the day-to-day business. A company's dividend policy can be reversed at any time and that, too, will not show up on its financial statements.
Cash Dividends Accounting
Cash dividends represent a company's outflow that goes to its shareholders and increases the shareholders' net worth. Dividend payment is recorded through a reduction in the company's cash and retained earnings accounts as a liability.
Because cash dividends are not a company's expense, they show up as a reduction in the company's statement of changes in shareholders' equity. Cash dividends reduce the size of a company's balance sheet, and its value since the company no longer retains part of its liquid assets.
However, cash dividends also impact a company's cash flow statement. Cash flow refers to the inflows or increases as well as the outflows or reductions in cash. Cash dividends impact the financing activities section of the cash flow statement by showing a reduction in cash for the period. In other words, although cash dividends are not an expense, they reduce a company's cash position.
Stock Dividends Accounting
A stock dividend is an award to shareholders of additional shares rather than cash. Similarly, stock dividends do not represent a cash flow transaction and are not considered an expense.
Companies distribute stock dividends to their shareholders in a certain proportion to their common shares outstanding. Stock dividends reallocate part of a company's retained earnings to its common stock and additional paid-in capital accounts. Therefore, they do not affect the overall size of a company's balance sheet.
How Dividends Are Paid
Whether paid in cash or in stock, dividends generally are announced, or "declared," by a company and are then paid out on a quarterly basis at a specified date. Investors are paid in proportion to their holdings. For example, a company might pay a dividend of .25 cents per share, payable 60 days from the date of the announcement.
A company's history of dividends is an important factor in many investors' decision-making process. Dividends tend to be most prized by relatively conservative investors who buy stocks for the long term, and by investors who value the regular income they provide. Dividend-yielding stocks are a component of most portfolios recommended by professional financial advisers.
As noted, there is never a guarantee that a dividend will be paid each year. However, some companies have earned boasting rights over their history of dividend payments. Coca-Cola, for example, notes on its website that it has paid a quarterly dividend since 1955 and that its annual dividend has increased in each of the last 58 years.
FAQs
Cash or stock dividends distributed to shareholders are not recorded as an expense on a company's income statement. Stock and cash dividends do not affect a company's net income or profit. Instead, dividends impact the shareholders' equity section of the balance sheet.
Is a dividend an expense to the company? ›
Dividends are not considered an expense. Instead, they represent a distribution of profits to shareholders. When a company earns profits, it can choose to either reinvest those profits back into the business (retained earnings) or distribute a portion of them to shareholders in the form of dividends.
Can dividends be deducted as a business expense? ›
Can a Corporation Deduct Dividends Paid to Shareholders? C corporations pay tax on their income before paying dividends. For them, dividends are not a deductible expense.
Is dividend a capital or expense? ›
A dividend is neither an income nor an expense for a company. Dividends do not impact a company's income or expenses in its financial statements. Dividends come out of shareholders' equity. Cash dividends reduce shareholders' equity.
How are dividends treated in accounting? ›
Treatment of Dividends in Financial Reporting
Under generally accepted accounting principles (GAAP), dividends are not considered an expense of doing business; instead, they are accounted for as a reduction of equity on the balance sheet and added back to net income to compute earnings per share.
Is dividend allowed as expense? ›
A stock dividend is an award to shareholders of additional shares rather than cash. Similarly, stock dividends do not represent a cash flow transaction and are not considered an expense.
Do dividends go through the P&L? ›
The total lamount of dividends paid during a period is shown on the Profit and Loss Statement for that period, since they are paid before the calculation of the Retained Profit.
What is the 60 day dividend rule? ›
A dividend is considered qualified if the shareholder has held a stock for more than 60 days in the 121-day period that began 60 days before the ex-dividend date. 2 The ex-dividend date is one market day before the dividend's record date.
What is the 45 day rule for dividends? ›
The 45-Day Rule requires resident taxpayers to hold shares at risk for at least 45 days (90 days for preference shares, not including the day of acquisition or disposal) in order to be entitled to Franking Credits.
Can dividends be considered business income? ›
Interest and dividends are a type of gross income and should be included in your total income. Visit Gross income for more information.
Once declared and paid, a cash dividend decreases total stockholders' equity and decreases total assets. Dividends are not reported on the income statement. They would be found in a statement of retained earnings or statement of stockholders' equity once declared and in a statement of cash flows when paid.
Do dividends count as income? ›
Key Takeaways. All dividends paid to shareholders must be included on their gross income, but qualified dividends will get more favorable tax treatment. A qualified dividend is taxed at the capital gains tax rate, while ordinary dividends are taxed at standard federal income tax rates.
What is the journal entry for a dividend? ›
A cash dividend journal entry is made when a company decides to distribute a portion of its earnings to its shareholders. Initially, the cash dividend journal entry involves debiting the “Retained Earnings” account, which reduces the company's equity, and crediting “Dividends Payable,” signaling the commitment to pay.
How are dividends recorded in accounting? ›
To record a dividend, a reporting entity should debit retained earnings (or any other appropriate capital account from which the dividend will be paid) and credit dividends payable on the declaration date.
How are dividends treated for tax purposes? ›
How dividends are taxed depends on your income, filing status and whether the dividend is qualified or nonqualified. Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%.
How do you treat dividends paid in financial statements? ›
After declared dividends are paid, the dividend payable is reversed and no longer appears on the liability side of the balance sheet. When dividends are paid, the impact on the balance sheet is a decrease in the company's dividends payable and cash balance. As a result, the balance sheet size is reduced.
Is a dividend a direct or indirect expense? ›
Dividend received is an indirect income which need to be shown in credit side of profit & loss account.
What do dividends fall under? ›
Dividends can be considered an operating expense, as they are paid out of the company's profits. This is the most common way to categorize dividends, and is typically used by businesses that have a large number of shareholders.
Is dividends tax an expense? ›
Taxation of Companies: Dividends Tax
A dividend is not deductible for tax purposes since it is not an expense in the production of income, but it merely represents a distribution of profits to shareholders.
